Taxable Accounts

Taxable accounts are one of the simplest versions of long-term investing. They lack the preconditions and restrictions of tax-deferred investing. There are no age limits, no restrictions on withdrawals, and no per-year investment limitation. In exchange for this flexibility, there is a significant downside - and it's right in the name: taxes.

First, the contributions you make to taxable accounts isn't deductible like a 401K or traditional IRA. That means the contributions are "post-tax", and don't help lower that years adjusted gross income on your taxes.

Second, the earnings on your income are taxable when those earnings are "realized". For example, if your taxable investment account balance grows from a $1K contribution to a $10K balance, you owe no taxes as long as the money remains in the account. That's because those earnings are "unrealized" - they only exist on paper. When you sell your investment, that sale "realizes" a profit of $9K ($10K value minus your $1K investment), and it's this $9K that you'll owe taxes on. This $9K profit is considered a "capital gain" and is subject to capital gains tax which varies based on how long you held the investment. If held for more than 12 months, the $9K is subject to the lower "long-term" capital gains rate, which currently stands at 15% for all but the very highest income folks.

While taxable accounts fall short of 401Ks and IRAs in the category of tax treatment, they really have an edge over those other options when it comes to liquidity. Liquidity is the "availability" of an asset. Cash for example is very liquid - if you have cash in your pocket, you can exchange that cash for a variety of items with very little effort. A house on the other hand is far less liquid. If you want to make the equity in your house available, you must find a buyer for that house (or pay a realtor to find one), wait a month or more for the transaction to close, and satisfy any outstanding mortgage debt. Only then will you have "liquidated" your investment.

Cash and homes represent two ends of the liquidity spectrum, but taxable accounts lie closer to the convenient cash end of that liquidity spectrum. If you decide you want to sell an asset in a taxable account, you simply call the company you invested through and say "sell". In short order, you'll have your funds. This ability to easily liquidate funds is a big advantage over tax-sheltered investments like 401Ks and IRAs which have strings attached to ensure the owner uses the funds for their retirement.

In summary, taxable accounts are available to all income levels and have no cap on amount invested.  They lack the tax advantages of the TSP and IRA options, so they're a worse choice for long-term saving since taxes will eat into your earnings. However, you have access to your funds whenever you'd like, unlike TSP and IRA where you may have to pay a penalty to withdraw prior to your 59th birthday. Taxable accounts deserve consideration when developing your long-term investment strategy.